Insurance agency owners are on the front lines of a hard market and are often called upon to provide solutions when the traditional markets are unable or unwilling. While temporarily enjoying the rise in revenue as a direct result of corresponding premiums, owners who have gone through a hard market (or two) know business can be lost forever to alternative risk transfer providers while the insurance carriers replace lost capital and increase policyholder surplus. An agency captive, however, can be an ideal platform from which owners can provide additional capacity and coverage to their clients, which can lead to higher retention ratios and increased client loyalty.
Is it a good fit?
Determining whether an agency captive is a good fit for your firm can start with a discussion with a qualified captive manager or consultant who has experience in agency or brokerage operations. Most often, a good starting place is to examine the volatility of the book of business and the risk class. Many firms will work with an agency owner in an early stage by conducting a “pre-feasibility” study. This early stage assessment provides the owner a conceptual risk/benefit analysis before the owner spends money and resources on a feasibility study, which includes an independent actuary to forecast losses.
What does it take to consider an agency captive? Usually, a premium commitment of at least $3 million to $5 million in the first few years, though in this prolonged soft market, some captives are starting with less than $1 million to $2 million. A good business plan is a must. As for losses, an ultimate loss ratio of less than 50 percent is often desired by the front. Ideally, the loss history will show frequency but not severity.
Minimum statutory capital required among U.S. domiciles typically range between $250,000 – $500,000, although I agency captives have been established with less, especially when organized under an existing protected cell captive. In cases where a protected cell captive is used, the states’ captive regulator may base opening capital and surplus on the business plan which may be a lower figure than the statutory requirement. Of course, some domiciles do not allow agency captives to be formed under their jurisdiction.
If the book under consideration is a program or some type of underwriting niche/specialty offered by managing agencies or wholesalers, a marketplace representing $30 billion in commercial premium, you will find perhaps more opportunities for alignment and appetite with carriers offering similar coverage and underwriting differentiation. Lines of business are varied, but many include workers’ compensation, auto liability, general liability, warranty and increasingly, property.
While fronting carriers seem to be abundant right now, that could quickly change when the market turns. If you have a program that does not require a front, formation may be easier and less costly. As mentioned before, the captive will require capital and collateral, especially if the program is fronted. Like all other captives and carriers, owners can experience adverse development, poor cash flow and erosion of capital. Under extreme situations, the owners may lose their entire investment. A properly conducted feasibility study and business plan execution should, however, greatly minimize the chance of these events from occurring.
While agency captives are extremely useful in helping to increase revenues for their owners, a well thought out captive ownership structure can include key employees who are vitally important to the ongoing operations of the agency. Employees can be rewarded with a share in underwriting profits of the agency captive. Profits can also be used to invest in new technology, acquiring a competing agency business or funding for perpetuation plans. Policyholders may also be invited to participate in captives as investors to reward loyalty and to induce good risk management controls to their business, increasing the likelihood of continuously producing a solid operating EBITDA. Collectively, all of these indirect benefits can increase the valuation of your agency as owners consider a perpetuation or exit strategy.
The outlook for developing an agency captive have never been more favorable to owners of agencies, brokerages, managing general agents and program administrators. Carriers with excess capital are searching for acquisition targets. An important part of their strategy, however, is rooted in continuous top line growth coming from experienced insurance intermediaries that share similar underwriting philosophies, professional services and corporate values. One very effective method to entice that top line growth and profitability is to offer significant profit sharing incentives through an agency captive. This bodes well for owners as they are already in a seller’s market and leverage is in their corner.
About the Author
Chris Kramer is Senior Vice President – Business Development of Caitlin Morgan Insurance. Chris is a veteran consultant with rich experience in captive solutions for small and mid-sized businesses, including insurance agencies, brokers, MGAs and other insurance intermediaries.